
Before selecting an ETF, an advisor should get to know the investment manager – the firm’s professionals, process, philosophy and performance. Firm philosophies on product development, experience and expertise can vary greatly. In reviewing the prospectus, especially for an active strategy, examine the manager’s investment process.
• Can it employ inverse and leverage strategies?
• Can it use derivatives as part of the investment process, and if so, does the manager use them for risk management or to take bets?
• Can the ETF contain swaps by structure?
Additionally, is the ETF created in-kind or with cash? This could have a financial impact on the client’s portfolio.
More broadly speaking, financial advisors should get to know the investment manager by examining the following.
• Depth of investment expertise
• Strategies used to manage tax consequences
• Management of turnover
• Handling of transaction costs
• Tactics used to deal with tracking error
• Use of optimization, replication or representative sampling
• Fiduciary experience
• Philosophy
BE SKEPTICAL
In creating a customized due diligence process, advisors must take care to avoid some of the most common misconceptions. Following are three key considerations.